How to Never Run Out of Money in Retirement. Too Good to be True?

As I approach retirement, or as I prefer to call it, “work-optional” status, setting up the best draw-down strategy becomes a more urgent matter and one that I obviously would like to optimize.

One option is familiar to anyone who’s ever looked into retirement planning — the 4-percent rule.

First formulated by financial planner William Bengen in the 1990s, this rule suggests that you can safely draw 4 percent of a 50/50 portfolio of large-cap US stocks and US treasuries, adjusting each year for inflation for 30 years.

FIRE Adherents’ “Bible” Number Doesn’t Guarantee Success

People who follow the Financial Independence Retire Early (FIRE) path routinely target a portfolio that’s 25× their desired draw in Year 1 of their early retirement.

That goal, 25×, comes from the mathematical inverse of 4 percent. Thus, if you want to draw $40k, you’d need $1 million (25 × $40k), because that $40k is 4 percent of $1 million.

However, Monte Carlo simulation studies have shown that the 4 percent rule isn’t always safe, even for a 30-year retirement, let alone for an early retirement that could last 40 years or longer.

In fact, in 2021, Morningstar published research that showed you’d have only a 90 percent likelihood of success with a mere 3.3 percent draw. The following year, this increased to 3.8 percent, and last year it reached 4.0 percent.

Stated differently, the most recent research shows you’d have one chance in 10 of running out of money in a 30-year retirement with a 4.0 percent initial draw!

The most recent research shows you’d have one chance in 10 of running out of money in a 30-year retirement with a 4.0 percent initial draw!

Note that the 4.0 percent required a 40/60 stocks/bonds + cash portfolio. The 50/50 allocation allowed only a 3.9 percent 90-percent safe initial draw. 

The 40/60 case, starting with $1 million, had a median Year-30 remaining balance of $1.5 million.

Are There Any Zero-Risk Paths to a 30-Year Retirement?

That same Morningstar report detailed several options other than the static withdrawal of 4.0 percent, each with its own pros and cons.

Three options described in the report allow a 100-percent success rate over 30 years. The fourth option below provides a 100-percent guarantee for any length of remaining life.

A 2.8-Percent Static Draw

This method succeeded in all 1,000 Monte Carlo simulations by reducing the initial draw from 4.0 percent to 2.8 percent from a 20/80 or 10/90 allocation. 

This method doesn’t absolutely guarantee success, but close enough for our purposes.

Your annual draws here are constant after adjusting for inflation, so you can count on a fixed annual spending amount. Since it results in a high median remaining balance after 30 years, you’d likely leave a large bequest.

However, this method suffers the obvious drawback that it reduces your safe initial draw by 30 percent, which means you’d be living on a more frugal budget than necessary.

The RMD Method

Here, each year, you draw based on the government’s Required Minimum Distribution (RMD) process, using the IRS Single Life Expectancy Table, which provides a 4.4 percent safe initial draw if you start at age 65 (but only 3.2 percent if retiring at age 55).

That percentage grows a little each year as your remaining life expectancy drops (by slightly less than a year each year you survive).

Since you draw each year a percentage of your remaining portfolio, you can never run out of money no matter how many years you survive. The problem is that if your portfolio does poorly, the resulting RMD amount may be far too low to cover your expenses.

Thus, you may not run out of money, but you could starve to death. 

On the flip side, if the market treats you generously, you could have an incredibly rich retirement.

This method also leads to a near-zero remaining balance by Year 30, so you can’t count on leaving much of a bequest.

A TIPS Ladder

Here, you start by buying Treasury Inflation-Protected Securities (TIPS) in 30 tranches that mature in a year, two years, three years, etc. up to 30 years. 

Each year, you spend the interest you receive plus the value of that year’s maturing TIPS.

While the value of your TIPS will fluctuate a lot, that won’t affect you because you’d be holding each TIPS to maturity, at which point you’re guaranteed its face value.

This option currently provides a historically high safe draw of 4.6 percent, is guaranteed by the US government, and is immune to inflation.

The main drawback is that at Year 30, you’re left with $0, so if you live beyond that, you’ll have nothing left and will, in any case, leave little or nothing if you survive close to 30 years. 

Another drawback is that there’s little to no flexibility if you’re hit with unexpectedly large expenses.

Note that you could modify this approach to provide for living longer than 30 years in retirement by allocating some of your portfolio to equities that you’d let grow for the first 30 years and/or to buying 30-year-deferred annuities, which would provide income beyond 30 years. 

However, this would require reducing your TIPS ladder size, reducing your annual draw in the initial 30 years.

The TIPS/equity approach would leave a potentially large bequest, which the TIPS/annuity option (see more below) would not. However, the equity option wouldn’t provide a guaranteed level of income past Year 30, which annuities would.

Morningstar estimates a median Year-30 balance of $1 million (not adjusted for inflation) if you started with $1 million and bought enough TIPS to provide a 4.1 percent safe draw.

If you want to double the median remaining balance to help account for inflation, the safe TIPS draw drops to 3.5 percent.

Jorey Bernstein, Executive Director, Wealth Manager, and Founder, Bernstein Investment Consultants, agrees this could be a good approach, saying, “A TIPS ladder can be a valuable tool for risk-averse retirees seeking guaranteed predictable income and inflation protection. It’s not a one-size-fits-all solution, but it can be a good option for retirees who prioritize safety and predictability.”

Fixed Immediate or Deferred Annuities

The Schwab annuity calculator currently estimates a 7.4-percent draw for a single-life-only immediate annuity. This compares very favorably with any of the above options.

However, since payments stop when you die, you won’t leave any bequest (you could pick some other option than single-life-only that would leave a modest bequest if you died early, but that would reduce your payouts).

The biggest drawback with this method is that over 30 years, even a 2-percent inflation rate (the Fed’s target, not always achieved) would cut your purchasing power by 45 percent, while a 3.5-percent inflation rate (the long-term average in the US) would cut it by 64 percent!

Omar Morillo, Founder of Imperio Wealth Advisors, suggests another type of annuity as a potentially better alternative, “We’ve found that Registered Index-Linked Annuities (RILAs) offer a compelling alternative to the traditional 4-percent rule, especially for those concerned with market volatility and income predictability. RILAs provide a way to participate in the upside potential of the equity markets while protecting against significant losses, address longevity risk by offering lifetime income options, ensure retirees do not outlive their savings, and can include features like death benefits, offering estate-planning advantages. This blend of features makes RILAs an attractive choice for those seeking a balanced approach to retirement income that adapts to personal needs and market dynamics. These decisions should ideally be made with the guidance of a financial advisor.”

Should You Try to Retire with a Zero-Risk Approach?

There are many ways to plan for retirement beyond the venerable (but not guaranteed) 4-percent rule.

Personally, I prefer the Guardrails approach — it’s not 100 percent guaranteed to succeed for a 30-year retirement, but it allows for high annual draws while leaving a sizable bequest.

If you prefer to optimize for a zero-risk 30-year retirement, the above shows four options (some guarantee it no matter how long you live in retirement). Each option comes with pros and cons and will thus appeal to different people.

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Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.